Bank competition and high profits

Mike Konczal (via Paul Krugman) asks how loss of franchise value and increasing competition in the financial sector can lead to high profits.  One theory is that loss of franchise value and increasing competition set off the destabilization of the financial sector.  Now that plain vanilla banking is no longer profitable, the only way the bankers can make money is by looting (a la Akerlof and Romer).  The high profits are just a by-product of an efficient looting agenda — that is, unless you can claim high profits, you can’t pay high salaries — so of course profits were high.  Leverage and the fabrication of “safe” assets are just the details of the looting mechanism.

This theory argues that the only way to have a banking system that can be stabilized is to limit competition and give banks back their franchise value, so they can go back to plain vanilla banking — this is just an extreme version of the Volcker rule.

(I haven’t thought enough yet about what weight I would put on the credibility of this theory.)

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